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Pound Sterling Steadies Against Euro and Dollar Ahead of Reeves Appearance

Published 14/01/2025, 07:38
© Reuters.  Pound Sterling Steadies Against Euro and Dollar Ahead of Reeves Appearance

© Reuters. Pound Sterling Steadies Against Euro and Dollar Ahead of Reeves Appearance

GBP/USD
-0.82%

PoundSterlingLIVE - Above: File image of Chancellor Rachel Reeves speaking in parliament. Still from Parliament.tv.

The under-pressure British Pound will look to the Chancellor of the Exchequer to bail it out today.

Rachel Reeves will give a statement regarding a recent trip to China; however, opposition parties will have the opportunity to press her on ongoing market concerns linked to the surging cost of UK debts and the fall in the Pound.

The Chancellor has been conspicuous by her absence in recent days, with the only official communications from her Treasury department coming via official statements and an appearance by her deputy, Darren Jones.

The government has said it won't change the course of its spending and taxation plans, despite falling economic growth and a rout of UK bonds and the Pound.

Investors will want to hear whether the Chancellor has, in fact, been pondering the issue and will respond to growing funding costs by delivering new policies to restore confidence in the UK.

Borrowing costs have surged, and the Pound fallen, in the wake of evidence the economy has flatlined since Labour took control. Reeves had promised to boost growth in order to fund a huge increase in public spending in the coming years. Without growth, the government will struggle to repay its debt.

The Pound to Euro exchange rate has fallen for four days in succession and is holding out at 1.1911. The Pound to Dollar exchange rate is under substantial pressure, having fallen to its lowest level in nine months at 1.2099, but is now stabilising at 1.2210.

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Although it is now oversold in the short term, the Pound has so far shown little interest in rebounding, confirming markets have not seen any indication that the government intends to make the necessary changes to boost confidence in the UK's debt dynamics.

Reeves will come under pressure to cut spending and/or raise taxes in 2025, with most economists predicting a combination of the two as she now has no room to meet her fiscal rules, the most important being that debt must start falling as a percentage of GDP by 2029.

However, tax hikes were tried in October and survey after survey has indicated the decision has severely dented business confidence and led to a retrenchment in growth and employment.

Above: GBP/USD hit oversold conditions (see RSI in lower panel), and has scope to enter a relief bounce.

"Business sentiment took a sharp turn for the worse in the latter months of the year, as business leaders digested the full implications of the government’s early policy decisions. Business was dismayed by the tax increases announced in the Autumn budget, and also concerned by the aggregate impact of proposed employment law reforms," says Dr. Roger Barker, Director of Policy at the Institute of Directors.

UK 10-year gilt yields, the benchmark government that investors typically watch, have risen to 17-year highs on fears that the economy is in stagflation, where rising inflation meets weakening growth.

"Sterling has been in focus this week as the clear underperformer in G10 FX, with the bear steepening and underperformance in UK gilts alongside the currency sell-off characteristic of an acute rise in UK fiscal risk premia," says Kamakshya Trivedi, an analyst at Goldman Sachs (NYSE:GS).

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Above: GBP/EUR is close to being oversold. It has met the key 200-day moving average (blue line), which could offer technical support.

Reeves will speak today in Parliament but could struggle to command the market's confidence. She repeatedly said she would deliver growth via pro-business policies in the lead-up to the election but delivered the exact opposite.

"All the chatter on FICC desks is that rather than reconsider the spending side of the ledger; the UK govt will come back for more tax in a self-defeating cycle. Again, whilst the govt has said it won't, it also hasn't definitively ruled it out - so no one really believes the promise as Reeves is seen to have lied in opposition about tax plans," says Simon French, Chief Economist & Head of Research at Panmure Liberum.

With her credibility in question, Reeves might find any statements that promise to deliver growth as a way out of the recent market troubles to be ineffective.

Solid policy commitments are needed, with the most effective likely to be a commitment to cut the UK's benefits bills significantly. There have been reports of such a desire, but nothing official, and Reeves knows her left-wing Labour Party colleagues would balk at such a commitment.

Instead, Prime Minister Keir Starmer has indicated the preference would be to fight a war on waste in the UK's departments, pressing them to find cost savings.

Markets don't think this is enough and there is a risk Reeves attempts to adopt a strategy of lying low and hoping the market settles on its own volition.

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"With the market’s not-too-distant memory of previous fiscal risk episodes, the clear risk to Sterling from here is an escalation in the loop of sell-offs in UK assets and a more strenuous fiscal position," says Trivedi.

We Won't Chase the GBP Selloff

However, Goldman Sachs FX analysts are not inclined to chase the Pound lower at this stage: "while the recent GBP weakening is likely primarily a UK-specific story, we think it can also partly be explained by the broader risk-off price action in FX markets this week, and as such an eventual recovery in risk appetite should lend some support to the Pound."

Trivedi adds that market dynamics are likely to improve, with both the macroeconomic and bond supply pictures pointing to an eventual compression in fiscal risk premium in Gilts, "which we think would also imply some pricing-out of fiscal risks in the currency."

Goldman Sachs thinks the UK data pulse can improve in the coming weeks, in part helped by a rise in government spending.

If analysts at the bank are correct, GBP weakness could soon fade, although it warns a number of risks remain. These include the dollar rally continuing as Donald Trump takes power and the Bank of England cutting interest rates faster and further than expected this year.

An original version of this article can be viewed at Pound Sterling Live

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